4 Key Risks Observed by the OCC for 2019
The Office of the Comptroller of the Currency (OCC) recently published its Semiannual Risk Perspective for Spring 2019, which provides a detailed analysis of the federal banking system and key risks facing banks. Overall, the OCC reported that the banking system is stable. However, some banks have increased their risk from previous years.
At a foundational level, the OCC found that credit quality is strong when measured by traditional performance metrics. Although capital levels remain near historic highs, the OCC has observed that due to years of economic growth, banks have slowly eased underwriting standards. There is growing concern about the increase of leveraged loans by both banks and nonbanks. In addition to leverage loans, the practice of risk layering (loans that contain a combination of low credit bureau scores, high debt-to-income, high loan-to-value, and/or other higher risk characteristics) continue to contribute to credit risk.
Cybersecurity risk continues to be a growing problem for the financial services industry. The increasing use of third parties to manage more and more functions continues to pose risks for institutions. The OCC raised concerns that some banks rely too much on third parties to support critical functions and services, which in turn could damage the operations of a bank in the event of a failure of the vendor's systems. The OCC specifically pointed out that cybercriminals are commonly exploiting the use of unsupported software and hardware by banks and third parties in order to gain access to sensitive systems and data.
Banks continue to struggle with managing Bank Secrecy Act/anti-money laundering risk. New products, services, and technologies continue to challenge compliance management systems, especially in understaffed departments. The OCC stressed the importance of retaining compliance expertise by having an established management process in order to continue to address compliance risk effectively.
To increase efficiency, some banks have started to implement new technology such as machine learning. According to the OCC, the adoption of AI or alternative data for establishing creditworthiness poses Fair Lending challenges while increasing complexity and limiting transparency. The OCC stressed that if the technology is being used to make credit decisions, banks must be able to defend their underwriting and modeling decisions.
Interest Rate Risk
The current uncertainty in the interest rate environment and competitive pressures have created challenges for banks. Banks are now directly competing against FinTechs and wealth management providers that continue to increase their offerings of low-risk, higher-yielding products. With advances in mobile and online banking, customers can now quickly move funds around, which can affect deposit stability and increase the difficulty of forecasting liability costs. The OCC stated, "even though short-term interest rates may stay near current levels for the rest of this year, there is potential that increasing liability costs may raise competitive pressures for core deposit rates and cause a shift to more wholesale funding, from non-maturity deposits (NMD) to time deposits or a combination."
Competition and changing customer preferences have continued to pose strategic risks to banks. According to the OCC, "29% of banks exhibit moderate or high levels of strategic risk." It's important to remember that through active self-monitoring, institutions can significantly lower their overall risk profile. If you are interested in reducing your compliance risk, contact us today!